SUMMITP U B L I C

LEXUS CLUB AT PNC PARK MAY 20, 2011

Tempered by a heavy dose of political realism, pension reform was in the air as the Allegheny County Retirement Board hosted its third annual Pension Summit on May 20, 2011, at PNC Park’s Lexus Club. “We’re under a different kind of pressure and scrutiny these days because of the size of the pension problem and what it will take to fix it”, said Tim Johnson, summit organizer and Allegheny County plan trustee, in his opening remarks. Pa has a $5 billion unfunded liability in municipal pensions; add SERS and PSERS that figure explodes by 2015. “ He and many of his Allegheny County colleagues emphasized consistently that this pension summit was part of the effort to be proactive and encourage tough but prudent decisions before their options narrow further.

Pennsylvania Senate Minority Leader Jay Costa (D-Forest Hills) summarized the status of state public employee pensions, including the reforms passed in 2010. Cost-saving measures included raising the minimum retirement age with full benefits from 60 to 65; raising the tenure required for full vesting from five years to eight; and dropping the multiplier used to calculate retiree benefits from 2.5 to 2. Costa said these changes will result in employer savings of $2.8 billion over 30 years.

Costa indicated that no further changes in state pension provisions are likely in the near future, but he expressed hope that legislation to reduce “spiking” by county and municipal employees, championed by him and State Rep. Matt Smith (D-Mt. Lebanon), could move forward in this session. The legislation would base pensions on an employee’s last four years of salary (rather than the last two) and would exclude overtime. “I think there is an appetite to address this issue,” Costa stated, “because we realize where it is leading.”

Following Costa’s remarks, the participants split up for two hours of breakout sessions to discuss aspects of the pension funding problem and possible solutions. Prominent themes emerging from the discussions are summarized below.

The Diagnosis

Although causes of the current pension crisis were old news to many of the participants, the discussants nevertheless generated an impressive array of contributing factors:

• Longevity. As Mary Esther Van Shura, Director of Community Affairs for the Onorato Administration, pointed out, U.S. life expectancy has grown from 65 years to 78 in the time since Social Security’s creation. Defined-benefit pensions designed to sustain a retiree for a few years are now providing

More than 120 pension, political, municipal and school district leaders participate at PNC Park’s Lexus Club.

By Bruce Barron, a frequent writer on issues of policy and politics

- 1 -

An Unmistakable Mood of Reform

monthly paychecks for decades. In many cases, employees who retire at age 55 or 60 with 25 to 30 years of service will live more years in retirement than they worked. • Generous pension terms. While participants acknowledged that the physical demands and safety risks faced by police and firefighters deserve consideration, many said that the costs have become greater than taxpayers can support. Jim McAneny, Executive Director of the Public Employee Retirement Commission, stated that five Pennsylvania cities are spending more money on police and fire costs alone than they generate in revenues. Mike Thomas, manager of Plum Borough, said that police there are retiring on pensions 25 percent higher than the borough’s median family income. Joe King, President of Pittsburgh Firefighters Local 1, countered that surviving widows of firemen who die on duty receive an average monthly benefit of just $625 a month; “Whatever you do, please don’t touch my widows,” he pleaded. • Nonmandatory benefits. Pension lawyer Rich Miller, who represents numerous Pennsylvania municipalities including the City of Pittsburgh, observed that many governments have awarded pension benefits beyond those required by statute, in such forms as cost-of-living increases or additional increments for years of service. Many plans, he added, have created a “super-annuated benefit” for employees who take disability retirement, setting their pensions at 60 or 70 percent of final salary rather than 50 percent—and thereby creating an incentive for employees to demonstrate a disability before their departure. • Rosy assumptions. Pennsylvania governments have shown a propensity for taking advantage of good market returns and assuming they would continue. When returns were high, as in 2000, employer contribution rates to the State Employees Retirement System (SERS) and Public School Employees Retirement System (PSERS) were lowered. McAneny of PERC described state legislation of 2003 (after the previous two years’ negative returns) as “throwing the accounting rules under the bus and making believe that I will earn my way out of this problem in 10 years by amortizing liabilities over 30 years, but gains over 10 years.” In contrast to Pennsylvania’s practice, Wade Steen, incoming Finance Director of Cuyahoga County, Ohio, noted that contributions to Ohio’s public pension funds—set at 10 percent for employees and 14 percent for employers—do not change from year to year. • History of public-sector compensation. As Miller pointed out, generous pensions were enacted half a century ago to encourage qualified employees to accept the lower wages in the public sector. Now, in many cases, the wages aren’t so bad—some kindergarten teachers and bus drivers earn $100,000 a year—but the pension benefits remain. Miller concluded, “We now have public-sector employees that we can no longer afford.” • Political interests. Former state legislator and current Allegheny County Councilman Bill Robinson provided a no-nonsense explanation of why many public employees receive nice pensions: “It seemed like a good idea many years ago to use public money to negotiate political support. So we public officials made a very promising pension program available to people whom we wanted to love us. Except that now the money has run out.”

Spiking: Whose Fault?

With Matt Smith, prime sponsor of state anti spiking legislation, moderating one of the breakout sessions, the spiking problem got detailed attention. Smith presented some imposing figures on what he called “the Allegheny County Pension Preservation Bill.” According to his calculations, a hypothetical employee retiring at age 55 on a final salary of $56,400 and actively accumulating overtime during his last two years

- 2 -

“I’m fortunate that I’m not an elected official,” remarked Jennifer Liptak, Allegheny County Council’s Budget Director. “To take a stand for change can be scary. But if we wait, the choices will be made for us.”

- 3 -

of employment could earn an annual pension of $91,000. With the provisions of Smith’s bill that number would be reduced to $34,800. The difference over 20 years would be more than $1.1 million—for just one employee.

While participants questioned, as actuarial consultant Mike Dieschbourg put it, “whether the implicit social contract entailed in pension promises was ever intended to encompass overtime,” many pointed out that there is more to the spiking story than employees creatively gaming the system. Joe King noted that the total complement of Pittsburgh firefighters has been reduced from 895 in the year 2000 to 625 today, saving salary costs, but necessitating greater use of overtime.

Steen, who also serves on a municipal council in Ohio, declared, “The only way that spiking can happen is if the manager is not managing overtime. People don’t just show up [for extra hours], they get scheduled. Someone is failing to manage the overtime budget and busting the pension budget besides.”

Van Shura pointed out the significant gender differences in relation to spiking, noting that female employees (except for teachers) tend to receive pension benefits based on lower salaries, but live longer after retirement; of Americans aged 85 years or older, more than two-thirds are women.

Schools: Way Out of Balance

Pennsylvania school districts face a distinct set of fiscal challenges, including the significant funding cuts contained in Governor Corbett’s first budget plus legislative proposals to enact a school voucher program and further limit school boards’ ability to raise taxes without a referendum.

Mt. Lebanon School Board Director Faith Stipanovich explained two dynamics that inflate school pension obligations in ways analogous to spiking in municipal and county governments. First, teacher contracts generally include a “jump step” that rewards veteran teachers, usually after 15 years of employment, with a large salary increase. Second, teachers can increase their total pay in the years prior to retirement by taking on various extra duties, with additional compensation stipulated in the contract.

Mike Panza, who deals with school finance issues as both Superintendent of the Carlynton School District and Moniteau (Butler County) school board member, pointed out that the 1992 legislation (known as the Mellow Bill for its sponsor, State Senator Robert Mellow) that let teachers retire after 30 years of service rather than 35 with no pension penalty “put a lot more people in the retirement system, and now we are starting to pay for it.”

The Republican-led General Assembly is moving to remove the ten exceptions that school districts can cite in order to raise taxes by more than the stipulated maximum. Van Shura said that 22 percent of the exceptions claimed have been due to rising pension obligations. Other cost-cutting ideas included changing the reimbursement formula for cyber-charter schools and rebalancing the bargaining environment by docking teachers a day’s pay if they go on strike. Mike Panza, Superintendent of Carlynton

School District (standing)

State Senator Jay Costa, Senate District 43 David J. Mayernik, Eckert Seamans Cherin & Mellott, LLCJennifer Liptak, Budget Director, Allegheny County Council, RBAC TrusteeJoseph King, Secretary/Treasurer, Firemen’s Relief and Pension Fund, City of Pittsburgh

Still More Opportunities

The summit’s closing session brought together a wide variety of players who have made innovative contributions toward addressing pension-related issues.

First to speak was Dormont council member Laurie Malka, who became an unintentional rabble-rouser last fall when she sought to educate her constituents on pension costs through the borough’s newsletter. Malka told summit attendees that, in her judgment, Dormont has had “20 years of inept labor negotiations and inadequate contract oversight, ending up with benefits that are now exorbitant.” Her newsletter article explained how borough staff used spiking strategies to increase their pension entitlement to as much as 90 percent of their final base salary. To help residents understand clearly the extent of the problem, a

chart accompanying the article displayed each employee’s salary without names, but with job titles.

Amidst the heated reactions to this article, Malka discovered that most residents thought spiking didn’t cost the borough any money. On the contrary, she said, Dormont’s minimum municipal obligation (MMO, the amount it must contribute to keep its pension system properly funded) rose from $130,000 to $177,000 in a single, two-year cycle. State aid (under Act 205 of 1984) currently covers this cost, but Malka said the borough is in effect “cosigning a loan” because, should the state aid go away, Dormont will still be responsible for the payments.

Wade Steen summarized the provisions of public pension reform legislation under development in Ohio. He indicated that the state legislature is expected to increase the retirement age by two years and to base pension calculations on the employee’s five highest salary years rather than the highest three.

Both Moe Coleman, Director Emeritus of the University of Pittsburgh Institute of Politics, and Joe King cited inequities in the state pension aid formula, which calculates payments to municipalities based on their current workforce. As a result, many suburbs (like Dormont) have their pension contributions fully state-funded while cities with shrinking workforces and large numbers of retirees receive only a fraction of what they need. Coleman also called the amazing fragmentation of Pennsylvania’s public pension system, with more than 3,100 plans, a source of inefficiency. In the two years since the Institute of Politics recommended consolidation of small pension plans, 47 new plans have been created—of which just four have more than 10 employees enrolled.

Paul Brahim, a partner with BPU Investment Management, focused on a more practical issue: helping employees do financial planning prior to retirement. He said that, according to a Wharton Business School study, 49 percent of high-paid employees reported having taken time off to deal with a financial crisis. Firms like IBM, Brahim noted, offer financial counseling to employees long before they approach retirement age. Failure to plan leads to absenteeism, but also “presenteeism” which is the situation where employees come to the office but spend significant work time on personal concerns, such as resolving their financial issues online.

Brahim also offered suggestions as to how employers, especially if they offer defined-contribution pension plans, can provide appropriate investment education to their employees so as to protect against the risk of litigation alleging breach of fiduciary duty.

- 4 -

Summit Consultant Dorien Nuñez warned governments considering a switch from defined-benefit (DB) to defined-contribution (DC) plans that they do not deliver the savings hoped for and bring other problems with them. Noting that West Virginia reverted to DB public-sector pensions after switching briefly to DC, Nuñez suggested that DC plans are more about shifting risk to employees than about saving money, and that they do not achieve higher returns. “If a water main breaks, I don’t want my city employees busy watching CNBC because they’re worried about their retirement plan investments,” he stated.

Jim McAneny reminded listeners that the pension problem gets worse every day, because the Pennsylvania Supreme Court has held consistently that, once a benefit is promised to a public employee, it can never be taken away. “So we have to do something going forward and not dig the hole any deeper or bring new people into a benefit system that is not sustainable,” he stated. Noting that municipalities are required to pay the calculated minimum municipal obligation but that the state has no such requirement, McAneny said that during the last 15 years Pennsylvania has not paid sufficient money into SERS and PSERS to keep them fully funded.

“We have to get the entire compensation system for government employees redone at the state level,” McAneny concluded. “The answers are simple, but politically impossible.” A major effort will be required to press the General Assembly into action.

The Solutions Tool Box

Just as the summit identified numerous causes of the present pension woes, it also generated a variety of possible solutions. Following is a series of options for pension managers and elected officials to consider:

• Use more reasonable assumptions regarding annual return on investments. County controller Mark Patrick Flaherty observed that the former standard assumption of an 8 percent annual return is often being lowered to 6 percent, which he believes will provide a more realistic picture and give governments a better chance of solving their funding problems. • Raise the retirement age; even a two-year increase delays everyone’s access to pension monies for two years, thereby making a huge contribution to plan solvency. • Raise the number of years required for employees to become fully vested. • Change the accrual percentages used to determine how much of the employee’s salary is accumulated in pension rights for each year worked. • Calculate pensions based on the last four or five years of base salary rather than the last two or three. • Implement anti-spiking legislation. • Follow Ohio’s example and grant employers no holiday on pension fund contributions. • Change the state aid formula to assist struggling cities more. • Place a minimum yearly contribution requirement upon state funds, just as is now required for municipal pensions by the Public Employees Retirement Commission. • Eliminate nonmandatory contributions to the pension fund.

- 5 -

Vince Larence of Twin Capital (left), Jed Robie of Federated (center), and Craig Moyer of Stoneridge Investment Partners (right).

Acknowledgements

Edwin R. BoyerPrincipal

Asset Strategy Consultants

Paul BrahimExecutive Vice President

BPU Investment Management, Inc.

Morton ColemanDirector emeritus, Advisor

University of PittsburghInstitute of Politics

Jay CostaState Senator

Mike DieschbourgManaging Director

Broadmark Asset Management

Vincent Gastgeb Allegheny County Councilman

Joseph KingSecretary/Treasurer

Firemen’s Relief and Pension Fund City of Pittsburgh

Michael LambCity of Pittsburgh Controller

Nancy LuttrellVice President, Retirement and Actuarial Services

Cowden Associates, Inc.

Laurie MalkaCouncilperson

Borough of Dormont

David J. Mayernik, Esq.Eckert Seamans Cherin & Mellott, LLC

James L. McAnenyExecutive Director

Public Employee Retirement Commission

Rich Miller, Esq.Partner

Campbell Durant Beatty Palombo & Miller P.C.

Dorien NunezManaging Director

Omniresearch

Jim PerryExecutive Director

PA Association of PublicEmployee Retirement System

Bradford L. RigbySenior Consultant and Actuary

Cowden Associates, Inc.

Randall Rhoades, Esq.Rhoades & Wodarczyk LLC

William RobinsonAllegheny County Councilman

Matt SmithState Representative

Wade SteenPresident

Steen & Company

Mary Esther Van Shura, Ed.D.Director of Community Affairs

Office of County Executive Dan Onorato

Sponsors Twin Capital Management

Andy Balogh

Federated InvestorsJed Robie

Mellon CapitalDiane Hallett

PIA Christine Sasse

BNY MellonCarlos Pacheco

iNetworksAnthony Lacenere

PFM AdvisorsJohn Spagnola

Presenters

Summit Consultant: OMNIResearch- 6 -

Tim JohnsonSummit Organizer

Snow Capital ManagementDavid Mathews

Eckert Seamans Cherin & Mellott, LLC David J. Mayernik

Asset Strategy ConsultantsEdwin Boyer

Draper Triangle VenturesJay Katarincic

ValStone Partners Larry Jennings

RBAC Trustees John K. Weinstein

Allegheny County TreasurerRBAC Chairman

Ted PuzakRBAC Vice Chairman

Mark Patrick FlahertyAllegheny County Controller

RBAC Secretary

William GallagherRBAC Trustee

Timothy H. JohnsonDirector of Administrative Services

Allegheny CountyRBAC Trustee

Jennifer LiptakBudget Director

Allegheny County CouncilRBAC Trustee

Dan OnoratoAllegheny County Executive

RBAC Trustee